Why Tesla’s Stock Is in Ludicrous Mode

It can thank the promise of its business—but also the weaknesses of GM and Ford.

It’s easy to tut-tut over the remarkable run of Tesla’s stock. Here’s a company that makes a few thousand cars per week, that hasn’t demonstrated it can mass-produce an affordable car, that routinely loses money, and whose chief executive is split among several other ventures. Yet it sports a market capitalization of about $48 billion. That’s more than Ford is worth and almost as much as General Motors—and briefly this week, it soared higher than both. Making this all the more shocking is that in the most recent quarter, GM and Ford reported revenues that were nearly 20 times those of Tesla, and both posted significant profits.

Tesla’s ludicrous-mode stock rally has caused many veteran Wall Street observers to question the wisdom of buying a stock so richly valued, as James Stewart did last week in the New York Times. But there’s a part of the equation that they’re missing. The reason that Tesla is worth as much as General Motors and Ford isn’t just that Tesla is worth a lot given its financial size; it’s also that General Motors and Ford aren’t worth that much given their financial sizes.

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As much as investors are buying into the Tesla story, they’re reluctant to buy into the stories of GM and Ford, which trade at a paltry 5.7 and 9.8 times earnings. That’s because those companies still carry some of the heavy baggage that lead them into a deep crisis less than a decade ago—baggage that you won’t find in Tesla’s trunk. Both are exposed to broad consumer markets in an aging, uneven economic expansion, and both spend huge sums of money on items that Tesla doesn’t.

These days, companies of all sizes in all industries use technology and their understanding of market dynamics to produce just enough inventory to satisfy demand and restock quickly. Otherwise you tie up capital unnecessarily and risk getting stuck with inventory you can’t sell—which kills profits. Tesla sells every car it makes almost immediately and has paid reservations for hundreds of thousands of vehicles it has yet to make. Its customers, in other words, are funding the construction of the vehicles.

By contrast, General Motors reported 926,170 vehicles in inventory at the end of March—enough to meet sales demand for 98 days. Ford reported 701,801 vehicles in inventory about the same time, enough to meet sales demand for 80 days. Those figures represents tens of billions in capital tied up for months at a time.

Of course, when you have lots of inventory and sales slow unexpectedly—as they have this year—you have to cut prices aggressively to move vehicles off the lots. And that hurts profits, too. Whereas Tesla generally avoids significant discounts, GM said that in March 2017 incentives (read: discounts) were 13.9 percent of the average transaction price; the average incentive Ford offered in March 2017 was up $1,800 from last year.

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Incentives alone aren’t enough to induce people to buy new cars. You have to offer them cheap financing. And, once again, this is a potential problem for the big automakers. With the economy eight years into an expansion and auto sales at record-high levels, automakers seeking new buyers for mid-priced cars have to turn to people who may not be the best credit risks. In 2016, the share of new auto loans issued to customers with subprime credit scores rose significantly, and some lenders are pulling back. These developments have little effect on Tesla’s sales but could have a significant impact on the revenues of General Motors and Ford.

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Mr. Gross glosses over another reality of Ford and GM: Labor structures. Tesla got the NUMMI plant where they make all their cars when GM was in belly-up mode and Toyota wanted out. More...

What’s more, GM and Ford willingly burden themselves with a recurring legacy cost that Tesla avoids: advertising. Tesla spends money on marketing, but it doesn’t advertise much. In 2015, GM and Ford ranked third and fifth on Advertising Age’s list of the largest U.S. advertisers, respectively, spending a combined $7.2 billion—a sum greater than Tesla’s revenues of $7 billion for all of 2016.

Of course, in some ways the big automakers have changed a great deal since the recession: They’re leaner, better managed, and more savvy about managing their debt loads. But they haven’t fundamentally altered their business models or cost structures in a way that insulates them from disruption or long-term risks. They pump out huge quantities of vehicles, make most of their profits from gas-guzzling pickups and SUVs, and rely on incentives, credit, and advertising to move inventory off the lot. It’s a model that works in good times, but that proves disastrous when economic growth stalls or gas prices spike. Stock markets are famously futures markets. And it’s possible General Motors and Ford are only worth roughly as much as Tesla because investors don’t believe the companies have done enough to make themselves future-proof.